US Dollar Slides on Fed’s Dovish Neutral Rate Interpretation

A The combination of broader resilience in the tech sector and some decent earnings reports helped European markets end the day higher yesterday, while US markets soared, led by the Nasdaq 100 , after a dovish rendition of Fed Chairman Jay Powell’s Q&A press conference.

As widely expected, the Federal Reserve raised rates by 75 basis points, from 2.25% to 2.5%, but Powell’s press conference seemed to raise more questions than answers. which may have been the intention, but also muddied the waters as to the Fed’s ambition. when it comes to fighting inflation.

While letting the market guess where monetary policy should go next gives the central bank leeway if it feels the need to slow the pace of rate hikes in the coming months, the ambiguity could also render its job of fight against inflation more difficult.

By acknowledging that spending and production in the economy had slowed in recent weeks and that consumer spending had followed the same path, Powell may have laid the groundwork for a possible slowdown in the pace of rate hikes, without say it categorically.

Powell went on to acknowledge that the FOMC still views inflation as way too high and that the committee was very mindful of inflation risks, but said that at current levels the fed funds rate is in the range of what they think is neutral, it seemed to catch the markets off guard.

This assessment of the neutral rate seems rather weak based on current projections, however its announcement that any future rate moves would be decided on a meeting-by-meeting basis, seems to suggest that the Fed is closer to the end of its hike cycle than the beginning.

Was this what Powell intended to convey?

With inflation already well above target, this neutral approach appears at odds with June’s year-end projections for a policy rate of 3.4% by the end of the year, and the Powell’s insistence that they want to see clear evidence that inflation is under control, which it clearly is not.

The market seems to have interpreted last night’s press conference as dovish, hence the sharp rise in US markets, the fall in short-term yields and the decline in the US dollar.

Whether that’s the correct interpretation will depend on the data in the days and weeks ahead, starting today with the current second-quarter GDP numbers and weekly jobless claims data.

Much time has been spent on questions about whether the US is in a technical recession, having experienced a -1.6% contraction in the first quarter. We’ll find out later today with the first iteration of Q2 GDP expected to come in at 0.4% after a decent number of durable goods in June yesterday.

Weekly jobless claims have also increased in recent weeks, reaching 250,000 last week, they are expected to remain stable at 250,000.

As we anticipate today’s European open, apart from the latest US GDP figures, European markets will be looking for signs of a further slowdown in German inflation in July. In June, this figure fell to 8.2% from 8.7% in May and is expected to fall further to 8.1%.

EUR/USD – rallied back above 1.0200 following the Fed’s decision, but needs to break past last week’s highs in the 1.0275 area to start. Although below, the risk remains for a return towards parity and the previous lows at 0.9950. A move below 0.9950, towards 0.9660.

GBP/USD – continues to tighten, as we approach the 50-day SMA and trend down from the February highs in the 1.2230 area. Support remains in the 1.1870 area with the bias remaining to the downside while below the 50-day SMA.

EUR/GBP – broke below the 0.8400 area with a risk of further losses towards 0.8300. resistance remains near the 0.8480 area.

USD/JPY – drifted lower after the Fed meeting, after failing in the 138.00 area. We have support in the 135.50 area. A breakout of 140.00 targets the 145.00 area. Major support lies at the 134.80 level and July lows.

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